Assume that YMC provides an incentive bonus to the CFO who is a CMA. The bonus is equal to 13…

Importance of cost classification and ethics

Young Manufacturing Company (YMC) was started when it acquired $40,000 by issuing common stock. During the first year of operations, the company incurred specifically identifiable product costs (materials, labor, and overhead) amounting to $24,000. YMC also incurred $16,000 of engineering design and planning costs. There was a debate regarding how the design and planning costs should be classified. Advocates of Option 1 believe that the costs should be classified as upstream general, selling, and administrative costs. Advocates of Option 2 believe it is more appropriate to classify the design and planning costs as product costs. During the year, YMC made 4,000 units of product and sold 3,000 units at a price of $24 each. All transactions were cash transactions.

Required

a. Prepare an income statement, balance sheet, and statement of cash flows under each of the two options.

b. Assume that YMC provides an incentive bonus to the CFO who is a CMA. The bonus is equal to 13 percent of net income. Compute the amount of the bonus under each of the two options. Identify the option that provides the CFO with the higher bonus.

c. Assume the CFO knows that the design and planning costs are upstream costs that must be recognized as general, selling, and administrative expenses (Option 1). Even so, the CFO convinces management to classify the upstream costs as product cost in order to increase his bonus. Identify two principles in the Statement of Ethical Professional Practice that are violated by the CFO’s behavior.